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2014-‐03-‐24
1
CIA4U Ms. Schirk
CHAPTER 2: DEMAND AND SUPPLY
¡ A market can be: § A physical place where goods are bought and sold § A collective reference to all the buyers and sellers
of a particular good and service § The demand that exists for a particular good or
service § The process by which a buyer and seller arrive at a
mutually acceptable price and quantity ¡ Market and economy are NOT synonymous
2.3 THE MARKET
¡ Demand: quantity of a good or service that buyers will purchase at various prices during a given period of time § Must have the desire and ability to purchase (so
demand only exists for those good that you both want and are able to afford)
¡ Law of demand: the quantity demand varies inversely with price, as long as other things do not change
¡ Ceteris paribus: meaning “other things remaining the same”
2.1 DEMAND
¡ Why is the law of demand true? § Substitution effect: as the price of a particular good
rises, we tend to substitute similar goods for it § E.g. buying no-name cola instead of Coca-Cola
when the price of the brand name rises, or buying the brand name instead of no-name when the price of Coca-Cola falls
§ Income effect: consumer income is fixed, so a rise in price limits the quantity they can purchase while a fall in price increases it § Real income: income measured in terms of the
amount of goods or services that it can buy
2.1 DEMAND
¡ Why is the law of demand true? (continued) § Law of diminishing marginal utility: as a person
increases consumption of a product (while keeping consumption of other products constant) there is a decline in the marginal utility (increased usefulness or satisfaction) that person receives from consuming each additional unit of that product § E.g. a buffet
2.1 DEMAND
¡ Demand schedule: a numerical tabulation (usually a table) of the relationship between price and quantity demand
¡ Demand v. quantity demanded: § Quantity demanded refers to the relationship that is
determined by price and is represented by a movement along the curve
§ Demand is affected by many other things, called demand determinants, and is represented by a shift of the curve
2.1 DEMAND
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2.1 DEMAND
If the price of t-shirts were… The consumer would buy in a given time period
(quantity demanded)…
$20 4 t-shirts
$24 3 t-shirts
$28 2 t-shirts
$32 1 t-shirt
$36 0 t-shirts
¡ Individual Demand: ¡ Demand curve: curved or straight line that graphically depicts the relationship between price and quantity demanded § Downward sloping because of the inverse
relationship between the two variable § X-axis is always quantity demanded § Y-axis is always price
2.1 DEMAND
P
P
QD
QD
¡ Demand curve:
2.1 DEMAND
Pric
e
Quantity
D
P$
Q 0
¡ Demand curve:
2.1 DEMAND
¡ Market demand schedule: considers the sum total of all the consumer demands for a product
2.1 DEMAND
Price of t-shirt
Buyer 1
Buyer 2
Buyer 3
Buyer 4
Total quantity demanded
$20 4 3 5 4 16 $24 3 2 4 3 12 $28 2 1 3 2 8 $32 1 0 2 1 4 $36 0 0 0 0 0
¡ Market demand:
2.1 DEMAND
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¡ Supply: the quantities that sellers will offer for sale at various prices during a given period of time § Suppliers react to prices opposite of consumers:
when prices rise, they want to supply more (while consumers want to purchase less) because they are driven by profit
¡ Law of supply: the quantity supplied will increase if price increases and fall if prices falls, as long as other things do not change
2.2 SUPPLY
¡ Supply schedule: a table showing the quantity of products supplied at various prices (though not actually sold)
2.2 SUPPLY
If the price of t-shirts were…
The seller would like to sell in a given time period (quantity supplied)…
$20 0 t-shirts
$24 4 t-shirts
$28 8 t-shirts
$32 12 t-shirt
$36 16 t-shirts
¡ Supply v. quantity supplied: § A change in the price level cannot change the
supply; it does, however, lead to a change in the quantity that a producer is willing and able to make available (hence a change in quantity supplied)
§ Quantity supplied refers to one relationship that is determined by price
§ Supply refers to the whole series of price and quantity relationships which are affected by supply determinants
2.1 SUPPLY
¡ Supply curve: curved or straight line that graphically depicts the relationship between price and quantity supplied § Upward sloping because of the direct relationship
between the two variables § X-axis is always quantity supplied § Y-axis is always price
2.2 SUPPLY
¡ Supply curve:
2.2 INDIVIDUAL SUPPLY
Pric
e
Quantity
S
P$
Q 0
¡ Market supply schedule: considers the sum total of all the consumer demands for a product § Market supply curve is upward sloping because as
price increases, current producers will produce more AND new firms will enter the market
2.2 SUPPLY
Price of t-shirt
Buyer 1 Buyer 2 Buyer 3 Buyer 4 Total quantity supplied
$20 0 0 0 0 0 $24 1 0 2 1 4 $28 2 1 3 2 8 $32 3 2 4 3 12 $36 4 3 5 4 16
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¡ Market supply:
2.2 SUPPLY
2.4 MARKET EQUILIBRIUM
Price of t-shirt
Market Demand
Market Supply
Shortage/Surplus
$20 16 0 -16
$24 12 4 -8
$28 8 8 0
$32 4 12 +8
$36 0 16 +16
¡ Equilibrium price: price at which no shortage or surplus occurs § No tendency for it change (i.e., it is stable) § The only acceptable compromise for sellers who
wan the highest price and consumers who want the lowest price
§ Price above equilibrium: surplus of goods § Price below equilibrium: shortage of goods
2.4 MARKET EQUILIBRIUM
¡ Why is the equilibrium price stable? § When a product is in surplus:
§ There is excess supply § Price is pushed down
§ When a product is in shortage: § There is excess demand § Price is pushed up
2.4 MARKET EQUILIBRIUM
2.4 MARKET EQUILIBRIUM
¡ Changes in demand: § are shown by shifts in the demand curve § are caused by changes in demand determinants § Occur when the ceterius paribus assumption is not
maintained
2.5 CHANGE IN DEMAND
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2.5 CHANGE IN DEMAND
0 1 3 5 7 9 11 13
Quantity Demanded (millions of kg per year)
Market Demand Curve for Strawberries
Market Demand Schedule for Strawberries
Quantity Demanded (millions of kg)
Price ($ per kg)
2.50
2.00
1.50
5
7 9 11
7 9
9 11 13
Pric
e ($
per
kg)
0.50
1.00
1.50
2.00
2.50
D0 D1 D2
(D2) (D0) (D1)
¡ Demand determinants include the following factors: § The number of buyers: an increase causes a
rightward demand shift (direct relationship) § Consumer incomes § For normal products, an increase causes a
rightward demand shift (direct relationship) § For inferior products, an increase causes a
leftward demand shift (inverse relationship)
2.5 CHANGE IN DEMAND
¡ Demand determinants (continued): § Prices of related products § For substitute (or competitive) products, a rise in
the other product’s price causes a rightward demand shift.
§ For complementary products (which must be used together), a rise in the other product’s price causes a leftward demand shift.
§ Consumer preferences § Consumer expectations
2.5 CHANGE IN DEMAND
§ Change in equilibrium: § A rightward demand shift pushes up both
equilibrium price and quantity. § A leftward demand shift pushes down both
equilibrium price and quantity.
2.5 CHANGE IN DEMAND
2.5 CHANGE IN DEMAND
0 1 3 5 7 9 11 13
Quantity (millions of kg per year)
Market Demand and Supply Curves for Strawberries
Pric
e ($
per
kg)
1.00
1.50
2.00
2.50
3.00 S
D0
15
a
3.00
2.50
2.00
1.50
1.00
Market Demand and Supply Schedules for Strawberries
Price Quantities
(D0) (D1) (S) ($ per kg.) (millions of kg)
D1
b
shortage 5
7
9
11
13
9
11
13
15
17
13
11
9
7
5 17
§ Changes in supply: § are shown by shifts in the supply curve § are caused by changes in supply determinants § Also affect the ceterius paribus assumption
2.6 CHANGE IN SUPPLY
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2.6 CHANGE IN SUPPLY
Market Supply Schedule for Strawberries
Quantity Supplied (millions of kg)
Price ($ per kg)
2.50
2.00
1.50
11
7 9 11
13 15
3 5 9
S0 S1 S2
Market Supply Curve for Strawberries
0 1 3 5 7 9 11 13
Quantity Demanded (millions of kg per year)
Pric
e ($
per
kg)
0.50
1.00
1.50
2.00
2.50
15
(S2) (S0) (S1)
§ Supply determinants include the following factors: § Number of producers (an increase causes a
rightward supply shift) § Resource prices (an increase causes a leftward
supply shift) § State of technology (an improvement causes a
rightward supply shift) § Prices of related products (an increase causes a
leftward supply shift)
2.6 CHANGE IN SUPPLY
§ Supply determinants (continued): § producer expectations (an expectation of lower
prices in the future causes an immediate rightward supply shift)
§ changes in nature (an improvement causes a rightward shift for some products)
2.6 CHANGE IN SUPPLY
§ Change in equilibrium: § A rightward supply shift pushes equilibrium price
down and equilibrium quantity up. § A leftward supply shift pushes equilibrium price up
and equilibrium quantity down.
2.6 CHANGE IN SUPPLY
2.6 CHANGE IN SUPPLY
0 1 3 5 7 9 11 13
Quantity (millions of kg per year)
Market Demand and Supply Curves for Strawberries
Pric
e ($
per
kg)
1.00
1.50
2.00
2.50
3.00 S0
D0
15
3.00 2.50 2.00 1.50 1.00
Market Demand and Supply Schedules for Strawberries
Price Quantities
($ per kg) (millions of kg)
5
7
9
11
13
13
11
9
7
5
17
15
13
11
9 17
S1
a
b
(D0) (S0) (S1)
Surplus
§ Price elasticity of demand: § the responsiveness of a product’s quantity
demanded to a change in its price § Elastic demand: demand for which a percentage
change in a product’s price causes a larger percentage change in quantity demanded
§ Inelastic demand: demand for which a percentage change in a product’s price causes a smaller percentage change in quantity demanded
2.7 ELASTICITY OF DEMAND
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¡ Price elasticity of demand (continued): § How to measure basic increases/decreases in demand or
price: § During winter, an ice cream vendor raises her price from
$2.00 to $2.40 § % change = P2 – P1 / P1 § = [($2.40 - $2.00)/$2.00] x 100% § = 0.20 x 100% § = 20% (therefore 20% increase)
§ Demand drops from 1000 to 500 cones § % change = D2 – D1 / D1 § = [(500 - 1000)/1000] x 100% § = -0.50 x 100% § = -50% (therefore 50% decrease)
§ The percentage decline in demand is greater than the percentage increase in price, so demand is elastic
2.7 ELASTICITY OF DEMAND 2.7 ELASTICITY OF DEMAND
¡ Price elasticity of demand (continued): § How to measure basic increases/decreases in demand
or price: § During the summer, an ice cream vendor raises her
price from $2.00 to $2.40 § % change = 20% (therefore 20% increase)
§ Demand decreases from 2000 to 1800 cones § % change = D2 – D1 / D1
§ = [1800 - 2000)/2000] x 100% § = -0.10 x 100% § = -10% (therefore 10% decrease)
§ The percentage decline in demand is less than the percentage increase in price, so demand is inelastic
2.7 ELASTICITY OF DEMAND 2.7 ELASTICITY OF DEMAND
¡ Price elasticity of demand (continued): § Perfectly elastic demand: demand for which a
product’s price remains the constant regardless of quantity demanded § E.g. A soybean farmer is a price-taker, as he has
no influence over the market price of soybeans § Perfectly inelastic demand: demand for which a
product’s quantity demanded remains the constant regardless of price § E.g. Insulin is essential for a diabetic, who will be
willing to pay any price for it
2.7 ELASTICITY OF DEMAND 2.7 ELASTICITY OF DEMAND
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§ Effect on total revenue: § Total revenue: total income earned from a product § TR = P x Qd
§ If a supplier raises his prices, that higher price itself raises the supplier’s revenue, BUT the decrease in demand has the opposite effect § Price elasticity of demand determines which of
these has the bigger effect on total revenue: increase in price or decrease in quantity demanded
2.7 ELASTICITY OF DEMAND
§ Effect on total revenue (continued): § Elastic demand: § Price increase of a certain percentage causes an
even bigger percentage decrease in Qdà TR is reduced
§ Price decrease of a certain percentage causes an even bigger percentage increase in Qd à TR is reduced
§ Inverse relationship between P and TR
2.7 ELASTICITY OF DEMAND
§ Effect on total revenue (continued): § Elastic demand (continued): § Blockbuster Videos
2.7 ELASTICITY OF DEMAND
§ Effect on total revenue (continued): § Inelastic demand: § Increase in price levels leads to a smaller
percentage decrease in Qdà TR increases § Decrease in price levels leads to a smaller
percentage increase in Qdà TR decreases § Direct relationship between P and TR
2.7 ELASTICITY OF DEMAND
§ Effect on total revenue (continued): § Inelastic demand: § Amusement park rides:
2.7 ELASTICITY OF DEMAND
§ Effect on total revenue (continued): § Unit elastic demand: § Demand for which a percentage change in price
causes an equal change in quantity demanded
2.7 ELASTICITY OF DEMAND
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§ Factors affecting price elasticity of demand: § Portion of consumer incomes: if the price
represents a hefty portion of consumer incomes, they will be more responsive to price changes
§ Access to substitutes: if there are many close substitutes, consumers will be more responsive to changes
§ Necessities v. luxuries: necessities have inelastic demand while luxuries (which are expendable) tend to have elastic demand
§ Time: demand tends to become elastic over time
2.7 ELASTICITY OF DEMAND 2.7 ELASTICITY OF DEMAND
Coefficient of demand elasticity
% change in quantity demanded
% change in price =
ed Δ Qd ÷ Avg Q Δ P ÷ Avg P
=
Effect of the change
Cause of the change
Note: Use averages
§ E.g. A gas station sells 10 million litres of gasoline a month at a price of $0.50 per litre. If the owners raise their price to $0.54 per litre, the quantity demanded falls to 9.5 million litres. Determine the coefficient of demand elasticity. § 1st: Calculate % change in price: § % change = P2 – P1 / Paverage
§ = $0.54 - $0.50 / [(0.54 + 0.50)/2] § = $0.04 / $0.52 § = 0.0769 à 7.69%
2.7 ELASTICITY OF DEMAND
§ E.g. A gas station sells 10 million litres of gasoline a month at a price of $0.50 per litre. If the owners raise their price to $0.54 per litre, the quantity demanded falls to 9.5 million litres. Determine the coefficient of demand elasticity. § 2nd: Calculate % change in quantity demanded: § % change = Qd2 – Qd1 / Qd average
§ = 9.5m – 10m / [(9.5m + 10m)/2] § = -0.5m / 9.75 § = 0.05128 à 5.13%
2.7 ELASTICITY OF DEMAND
§ E.g. A gas station sells 10 million litres of gasoline a month at a price of $0.50 per litre. If the owners raise their price to $0.54 per litre, the quantity demanded falls to 9.5 million litres. Determine the coefficient of demand elasticity. § 3rd: Use % changes in P and Qd to find coefficient: § ed = Δ Qd / Δ Pd
§ = 5.13% / 7.69% § = 0.667 or 0.67
2.7 ELASTICITY OF DEMAND
Note: It is no longer a concern whether Qd is negative since we are interested in the amount of change, not the direction.
§ E.g. A gas station sells 10 million litres of gasoline a month at a price of $0.50 per litre. If the owners raise their price to $0.54 per litre, the quantity demanded falls to 9.5 million litres. Determine the coefficient of demand elasticity. § 4th: Use coefficient to make a conclusion. § Less than one: inelastic coefficient § Greater than one: elastic coefficient
2.7 ELASTICITY OF DEMAND
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§ Price elasticity of supply: § the responsiveness of a product’s quantity supplied
to a change in price § Elastic supply: supply for which a percentage
change in a product’s price cause a larger percentage change in quantity (suppliers are responsive to change)
§ Inelastic supply: supply for which the percentage change in a product’s price causes a smaller percentage change in quantity supplied (suppliers are not as responsive to change)
2.8 ELASTICITY OF SUPPLY
§ Factors that affect the price elasticity of supply: § Short run: the production period during which none
of the resources required to make a product can be varied § Supply is said to be perfectly inelastic (supply for
which a product’s quantity supplied remains constant regardless of price)
§ E.g. Price of strawberries rises in response to sudden increase in demand for strawberries in April, but farmers cannot increase production
2.8 ELASTICITY OF SUPPLY
§ Factors that affect the price elasticity of supply: § Intermediate run: production period during which at
least one of the resources required to make a product cannot be varied § E.g. Price of strawberries rises in response to
increase in demand for strawberries in a particular growing season; farmers can add more labour, but they cannot bring more land into production
2.8 ELASTICITY OF SUPPLY
§ Factors that affect the price elasticity of supply: § Long run: the production period during which all
resources required to make a product can be varied, and businesses can enter or leave the industry
§ Constant-cost industry: an industry that is not a major user of any single resource
§ Perfectly elastic supply: supply for which a product’s price remains constant
§ Increasing-cost industry: an industry that is a major user of at least one resource
2.8 ELASTICITY OF SUPPLY
§ Calculating the price elasticity of supply § Similar to calculating the price elasticity of demand
2.8 ELASTICITY OF SUPPLY
Coefficient of demand elasticity
% change in quantity supplied
% change in price =
es Δ Qs / average Qs Δ P / average P
=
Effect of the change
Cause of the change
Note: Use averages
§ E.g. When the price of tomatoes rises from $2 to $3 a kg, the quantity supplied by farmers increases from 100,000 to 200,000 kg. § es = Δ Qs / average Qs
§ = (200,000 – 100,000) / [(200,000 + 100,000)/2] § = 100,000 / 150,000 $1 / $2.50 = 0.667
2.8 ELASTICITY OF SUPPLY
Δ P / average P
($3 - $2) / [($3 + $2) / 2
0.4 = 1.67
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